As our learned friend recently reminded us, economic policy is a zero-sum game. Every policy option which we can take to address slow economic growth or unemployment has costs, and the balance between costs and benefits is much more of a grey area than the usual simplistic debate over economic policy would have you believe. In America and Britain, a fierce debate is raging over whether the appropriate action to be taken in the economy is more cuts in spending to pay off debt - in Europe we call it "austerity" - or more spending to try to generate economic growth. There are various monetary policy steps which are also recommended to stimulate growth, but we're trying most of those anyway and they're not working. Hence, the focus rests on "fiscal stimulus".

The basic idea behind fiscal stimulus is that when you're faced with economies which aren't growing - and aren't generating enough jobs to even cover the number of new people growing up and entering the labour market, in America's case - the fundamental problem is that there's a lack of demand. Consumers and businesses aren't spending enough money, either because they haven't got any or because they're scared of what's going to happen in the future and are saving or paying off their debts. The solution, according to the theory, is for the government to step in and spend money to generate demand and get the economy moving again.

The government can either buy things directly from businesses or try to put more money in people's pockets through things like tax cuts. The result is supposed to be that as order books fill up and people have more money in their pockets, the economy eventually reaches some sort of take-off point where it becomes self-sustaining again - which will come as a relief to the government, because not only does the economy need to start growing normally again, it also needs to start growing fast enough to pay back the money which the government had to borrow to kick-start the economy in the first place.

If this all seems a bit abstract, here are a few concrete examples of things you might do as part of a fiscal stimulus. You might pay to do maintenance work on railways and highways, meaning that construction and maintenance companies get some business and avoid going bust, their employees have more money and so spend it - which helps other businesses - and you improve your infrastructure, which reduces transporation costs and so helps other businesses as well. Or you might pay the dole to unemployed people, meaning they can afford to continue to go shopping and keep the shops on the local high street in business. You might cut business taxes so that businesses have more money to invest. All of these things will, in various ways, help your economy.

That's what a fiscal stimulus is. It can help stave off total economic collapse for a short period, and it can help address the social evil of long-term unemployment. Democratic governments have to be responsive to the needs of their people, and we should never forget that. We should also never forget that even when they're not doing a "fiscal stimulus" per se, governments are spending a heap of money in the economy anyway - usually between about 20 and 40% of GDP in the developed world - and so are always, in a way, generating some growth. But we also need to remember something else. That thing is that the bedrock assumption of our entire economic system of capitalism is that the government can only do so much, and that it can't on its own develop sustainable growth. Societies and economies are too complex to be directed centrally, which is why socialism doesn't work. So we have to be humble about what the fiscal stimulus can accomplish.

As a crisis management mechanism, the fiscal stimulus can accomplish quite a lot - but as a route back to sustainable growth, it is a fantasy. Money which governments borrow to pay for fiscal stimulus eventually has to be paid back, which is a long-term commitment which will eventually require higher taxes or cuts in spending, both of which will lower economic growth. But the boost to growth given by the fiscal stimulus is, by definition, short-term. Consider my examples above. If my construction company is reliant on government contracts, or my shop is reliant on the handouts been given to my customers, or my business is reliant on tax breaks which are going to disappear eventually, then I'm going to end up filing for bankruptcy. Government money can't last forever, and government itself can't cause economic growth to happen - if it could, socialism would work. All the government can do is give the private sector breathing space to get its shit together.

But there are situations when the private sector is so incredibly damaged that any complete accounting of its shit lies some years hence. If consumers and businesses are so scared about their future prospects - if, say, governments are so indebted that the dismantling of pension provision and social security is being discussed, and the eurozone might be about to collapse - then all the fiscal stimulus in the world won't make any difference. If people get extra money, they'll use it to cover their asses - they'll pay off debts or they'll do whatever they can to survive, either as a business or a household. They're in crisis mode, and a bit of short-term govenrment money isn't going to help. Maybe it'll tide them over this year, but eventually they know they're going to be on their own. So they don't spend or invest normally. And until they have the confidence to do so, the economy won't function normally.

To put it simply, the stimulus has to be big enough, or the crisis has to be small enough, that everyone will forget about how bad the economy is and believe the good times are back. Then the money will flow again. This also relies on the external situation - how things are looking in the global economy - looking positive as well. After all, you can generate all the demand you want in your own economy and it won't matter a jot if some Greek fiscal crisis comes along and spoils the party.

This is why the current argument between spending cuts and fiscal stimulus is so frustrating. We're faced with a situation where our governments have never been so indebted, and might conceivably become unable to borrow; where our businesses and banks are so scared about the future that they're hoarding whatever money they can rather than investing or spending; where householders are worried about keeping roofs over their heads and body and soul together; where the eurozone might be about to fall apart, causing a new financial crisis which will ensure that the credit crunch is written about only, if I may quote George W. Bush, as "a prelude to far greater horrors". In light of all this, another $450bn fiscal stimulus to tide us over for another year while we wait for a miracle can seem either futile or our last best hope, depending on your perspective. The two sides continue to argue, their inability to act in any effective manner only increasing their vitriol. What neither seems to consider - or perhaps wants to admit - is that we may be completely, irretrievably, fucked.

Many people find it hard to follow the arcane arguments of economists. One reason for this is that economists today are in the same position as astrologers before the discipline of astronomy got its act together: what they say to explain and predict events makes a lot of sense given what we know about the world, and we have no better guide than the theories that they apply, but they do not in fact have much of a clue about what is really going on, for which reason much of what they say does not make much sense.

So it makes a pleasant change when an economic intervention is simple enough in principle to be explained in terms that a more or less sane and intelligent human being can understand. What follows is a re-telling of something a member of the German Financial Community recently sent me by email, origin unknown:

The Greek Rescue Package

It is a cold and rainy winter day in a small Greek village. No tourists have arrived, the streets are empty, times are hard, everyone is in debt and worried about what tomorrow may bring. A hired BMW pulls up in front of an empty hotel, and a German tourist gets out. He tells the hotelier he wants to look at the rooms to see if he would like to stay there. The hotelier gives him the keys in return for a deposit of €100, which the tourist leaves on the counter.

As soon as the tourist has disappeared up the stairs, the hotelier grabs the bank-note and runs to his neighbour, the butcher, to pay his debts.

The butcher takes the €100, runs down the road and pays his debts to the farmer.

The farmer takes the €100 and goes around the corner to his friend in the local farmers' cooperative to pay off his debts.

The man from the cooperative takes the €100, runs to the café, and pays off his bar tab.

When he has gone, the landlord pushes the note across the counter to the village whore, who has been going through difficult times and has done him a few 'favours' on credit.

The prostitute runs up the road to the hotel and uses the €100 to pay her last bill.

The hotel owner puts the €100 note back on the counter, just as the tourist comes down the stairs. He says he doesn't fancy any of the rooms, takes his €100, and leaves.

  • No-one produced anything.
  • No-one earned anything
  • Everyone has paid off their debts and looks to the future with confidence and optimism.

And that is how simple a fiscal rescue package can be.

What is not simple is finding the source of story like this once it has gone viral and been reposted all over the Intarwebs. My best informed guess is that it was posted without reference to any rescue package by 'Methodikus' on March 10, 2009 in a general discussion about the nature of money.

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